Yentervention..?
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Why is the Yen collapsing? And is MoF intervention inevitable?
This is a difficult question to answer without diving into the the macroeconomic factors that the Japanese government and the BoJ are trying to mitigate and overcome in order to achieve their objectives. It’s not simply a case of interest rate differentials, although I suspect this is a large factor as capital flight takes place and carry trades once again become profitable, but the extent of the yen’s weakness is far more nuanced and interesting than that.
We have to remember that Japan is trying to do the exact opposite of every other developed nation, that is to increase inflationary pressures and therein is a partial answer to the question. Japan has suffered decades of deflation and whilst deflation may sound appealing as goods get cheaper over time. This deflationary process leads to economic stagnation as consumers and business defer purchases, waiting to buy later at lower prices. This induces a toxic spiral of flat wage growth, business failures and job losses. Combine that deflation with low interest rates and we’re now putting ourselves in the position that the BoJ currently finds itself; with very limited scope to respond to any economic crisis and all but impossible to make real wage adjustments.
In March, the BoJ discussed a return to a ‘virtuous inflationary cycle’, the hope that domestic inflation; rising wages will jumpstart a cycle of domestically driven inflationary activity after decades of deflation. However, japans inflation has since slowed and at recent meetings it’s been discussed that a weaker yen could actually help aid them and spur price growth (and this is the important part) in-turn allowing the BoJ to achieve its inflationary objectives.
That being said, whilst a weaker yen may cause inflation, in my opinion (which means nothing) it would likely be the wrong type of inflation, one which may only exacerbate Japans economic woes. A depreciating currency will only increase the price imported goods, which for Japan includes most food and energy products, reducing inflation adjusted wages whilst simultaneously increasing capital flight thus, sending more money abroad which would further reducing the money that Japanese citizens (and business) have to spend on domestic goods and services. This form of inflation would not bring about the ‘virtuous inflationary cycle’ (domestically self-sustainable) that the BoJ is hoping for but as long as this strategy remains in play, I have to ask myself.. is it likely that the MoF will intervene again? And honestly, I don’t know. I think it would be futile to try and reverse the current trend, but I also understand the reasons why intervention may become necessary, and also why its aim may not necessarily be to reverse the trend, but serve to provide a reduction in volatility at how that is perceived by Japanese citizens, which I will discuss later on.
Japanese workers have seen two years of falling real wages and this may very well be suppressing Japanese consumer activity. An argument has been made that consumption growth would only return after consumers have recouped the purchasing power they’ve lost as a result of yen weakness related inflation. Moreover, that consumers would need several quarters of wage growth outstripping prices before a restoration of confidence would restore consumer spending to the point of sparking domestic inflationary pressures.
The phase of japans economic cycle and the intentions of economic policy are diametrically opposed to that of most other advanced economies, and so Japan actually pursues the exact opposite of what most other economies are trying to do. Well, to a point; they’re all trying to do the same thing in terms of end goals, restore price stability and healthy economic activity, but the Japanese policy makers are coming at it from an entirely different place.
In most other countries, labour markets have been tight and service inflation has been sticky to the point that markets are wondering when rate cuts could even begin. Rates cuts that had been previously priced in by participants are no longer expected. In contrast, Japans problem is that their service inflation is too low and must be risen if hopes for economic growth are to be achieved. Another important factor is that Japan’s corporate sector has had sufficient profits that enables big companies to recognise the demographic problems being faced by the country to the point that they can spend on capex to replace workers with capital.
A quick glance at Nikkei would perhaps make you believe that japan’s economy is performing okay as Japanese companies are posting record profits for the third year in a row, with profits 13% higher than the year prior and 6% higher than the year before that. Manufacturing profits are on target to grow 16% this year, with non-manufacturing hoping to climb 11%; both of which would see profitably at record highs. Japanese capex intentions are measured by the Tankan survey, which is also at multi-decade highs; previous peaks being around 6% to 7%, but the latest cycle has been up at 15%. Whilst previous predictions have been off by some 1-2%, the capex has seen 7-8% in growth already.
But Japans economy is anything but fine. Part of the driving factor behind the current corporate profitability in Japan is directly related to yen weakness and not Japans economic health. This is because most Japanese companies look to international markets for sales, growth, and investments. So whilst the yen has been spiralling, most of the companies listed on the Nikkei have international reach that has seen profits soar; partially due to yen weakness and partly due to loose monetary policies at home.
As we all know, one can’t simply devalue a currency to generate or inflate wealth but the yen’s decline has improved business profitability. Which I assume Japanese policymakers hope will lead to wage growth and capex. Currently, it has brought about inflation in a country that has suffered 3 decades of deflation, so I can understand why policymakers hope it will instigate consumer spending, before prices rise further… stimulating broader economic activity. But this approach has limitations and there’s obviously a limit to where everything can go. The BoJ discussed in a report that they are fairly confident that over a period of time, the Japanese economy will transition into a positive output gap, and that positive output gap will result in a steady income growth for workers which will lead to a sustainable growth in consumer spending. This being the ‘virtuous cycle’ the BoJ are predicting will ignite the furnace of the Japanese economy. A positive output gap only happens when demand is very high; actual output is greater than full-capacity output. In a situation where machines, workers and businesses are being stretched past capacity, companies end up having to pay more for everything in order to run at such levels which results in higher wages as overtime demand must be met. However, over time, companies must increase worker productivity, usually by spending capital on increased mechanisation, which is a necessity in Japan due to their aging population. This positive output gap isn’t sustainable in the long run but can be sustained over short periods of high economic demand, the main problem in Japan is that the origin of the demand responsible for this output gap is from overseas and due to domestic drivers. The idea that this positive output gap will feed into a domestically induced inflation rate is one that I’m uncertain about. It can create a situation in which production becomes amazingly high-tech, but how will that translate through to the labour market; workers replaced by mechanisation? I don’t know, I suspect a state subsidy will likely be introduced derived from the increased profits generated by mechanisation, but that quite some time off and Japan is a country that still has plenty of room for a healthy increase in such activities. Japan’s debt reached 8.6 trillion USD at the end of 2023, and at 255% of GDP, its more than twice the debt to GDP ratio of the US and is the highest in the developed world. Japan also has an aged population which is projected to produce the same number of retirees as workers by 2050.
Profits as mentioned earlier are at an all-time high, but real wage growth has remained weak and that is the main reason why policy makers are reluctant to increase rates and are pushing hard for higher wages. The BoJ have stressed that the timing of their decisions will be dependent on factors associated with wage growth in which policymakers are are hoping to see an increase in wages which will result in higher spending which will trickle through to the wider economy. This is a big change in a country that has seen stagnant wages and deflation for over three decades, people who have been salaried have actually benefited from this as wages, whilst flat, have been purchasing more goods due to the cycle of deflationary pressures. This creates an environment which is prone to low innovation and reduced risk appetite which is also a significant issue in Japan’s economy. But current labour shortages are forcing reforms which are resulting in the younger generation adopting a greater entrepreneurial spirit which is slowly improving economic diversity and slowly providing the BoJ with the confidence to raise rates as real wage growth becomes entrenched. In March, a 5.28% wage rise was agreed which is the biggest pay rise in 33 years. This change is a factor which impacted the decision to end the negative rate policies. Ultimately policy makers are worried about the yen for two reasons, the first being an erosion of corporate expectations, which makes little sense. And the second is that such a severe decline in yen strength could cause the wrong type of inflation as discussed earlier. Whilst this is economically sound, the corporate profits have been a function of a weak yen and if they try to strengthen the yen will hurt company profits and reduce the output gap and any future wage gains. This is the first time in the last few decades that corporate inflation expectations in Japan have actually increased substantially, but that’s because the government is on their case to lift wages, in-part due to the reduction in government party approval ratings which has been significantly damaged of late due to the fall of real wages. So now there’s building political motivations which are starting to impact the yen. Perhaps this may be the most significant factor in stimulating inflation as that would bring about the right kind of inflation, so policy makers need the domestic labour market to remain tight. The BoJ are also reluctant to raise rates because goods inflation is reducing whilst services inflation is significantly lacking.
The big winners from the weakness in yen are obviously the large cap companies who’ve generated global profits but remain denominated in yen; exporters who receive foreign exchange and financial firms with exposure to financial markets. Also the tourism sector has been running hot with the monthly visitors exceeding 3 million for the first time in March and climbing, again driven by a weak yen. When you combine a low yen with 30 years of stagnant wage growth it doesn’t exactly spur on economic activity.
In recent times, Janet Yellen has said that the G7 have agreements in place stating that any interventions should be implemented to smooth volatility only and not to influence exchange rates, which may explain why previous interventions haven’t had much success and have always been at times of rapid price movements. Her comments also suggest that Japan has not discussed any interventions with other G7 nations prior to stepping in, which they are duty bound to do so. Generally, any exchange interventions are a bilateral arrangement and successful interventions would likely involve a discussion between both sides; the fed in this case. This could again indicate why previous interventions have not worked and why they seem to be triggered in time with negative US news during hours of extremely low volume. Perhaps the BoJ should learn from the lessons taught by both turkey and Egypt who both failed in this endeavour, essentially squandering their entire respective central bank reserves on attempting to maintain an artificial fx price, one which later collapsed as soon as reserves dwindled. This leaves traders wondering, is there any point at intervention if the underlying problems are too great to justify a stronger yen in comparison to its western counterparts.
For me, it’s the pace at which the yen is declining which is most interesting, and this is starting to spook Japanese consumers which could very well result in a reduction of spending, which is the polar opposite to what the BoJ requires, so in that sense, intervention perhaps serves its purpose in which the ends inevitably justify the means. But at this rate some Japanese pundits are wondering if Japan will slip back to becoming an emerging market once again, which I don’t think is a serious possibility, just more of a motivational tactic. Whilst Japan’s economy has many problems, the risk of becoming an emerging market doesn’t seem so great, nor does it seem likely.
Ultimately, the main reason behind this post is to highlight the many factors behind the current exchange rate and to shine a light on nuanced economic policy that drives the yen lower. Personally, I think for any intervention to have any meaningful impact on currency prices, the government needs to reinforce the need for higher wages in order to stoke the flames of domestic inflationary pressures whilst the BoJ and the MoF work together, raising rates substantially backed by monetary intervention. But that should be at a time when the US either eases rates or the economy starts to show signs of slowing (which it has in its recent data prints). Lower inflation in the US seems to be the most likely scenario that would reduce the pressure that currently weighs on the yen as that would reduce rate differentials without Japanese intervention. In my opinion, that would seem like the perfect opportunity for Japanese policy makers to act in tandem; with intervention at the same time as rate rises. Furthermore, as Japan slows its rate of treasury purchases, the repatriation of yen will stem capital flight but it’s yet to be seen if that will be enough to stem further weakness.
What do you think… is the current price justified or is it due for an imminent mean reversion?
This is a difficult question to answer without diving into the the macroeconomic factors that the Japanese government and the BoJ are trying to mitigate and overcome in order to achieve their objectives. It’s not simply a case of interest rate differentials, although I suspect this is a large factor as capital flight takes place and carry trades once again become profitable, but the extent of the yen’s weakness is far more nuanced and interesting than that.
We have to remember that Japan is trying to do the exact opposite of every other developed nation, that is to increase inflationary pressures and therein is a partial answer to the question. Japan has suffered decades of deflation and whilst deflation may sound appealing as goods get cheaper over time. This deflationary process leads to economic stagnation as consumers and business defer purchases, waiting to buy later at lower prices. This induces a toxic spiral of flat wage growth, business failures and job losses. Combine that deflation with low interest rates and we’re now putting ourselves in the position that the BoJ currently finds itself; with very limited scope to respond to any economic crisis and all but impossible to make real wage adjustments.
In March, the BoJ discussed a return to a ‘virtuous inflationary cycle’, the hope that domestic inflation; rising wages will jumpstart a cycle of domestically driven inflationary activity after decades of deflation. However, japans inflation has since slowed and at recent meetings it’s been discussed that a weaker yen could actually help aid them and spur price growth (and this is the important part) in-turn allowing the BoJ to achieve its inflationary objectives.
That being said, whilst a weaker yen may cause inflation, in my opinion (which means nothing) it would likely be the wrong type of inflation, one which may only exacerbate Japans economic woes. A depreciating currency will only increase the price imported goods, which for Japan includes most food and energy products, reducing inflation adjusted wages whilst simultaneously increasing capital flight thus, sending more money abroad which would further reducing the money that Japanese citizens (and business) have to spend on domestic goods and services. This form of inflation would not bring about the ‘virtuous inflationary cycle’ (domestically self-sustainable) that the BoJ is hoping for but as long as this strategy remains in play, I have to ask myself.. is it likely that the MoF will intervene again? And honestly, I don’t know. I think it would be futile to try and reverse the current trend, but I also understand the reasons why intervention may become necessary, and also why its aim may not necessarily be to reverse the trend, but serve to provide a reduction in volatility at how that is perceived by Japanese citizens, which I will discuss later on.
Japanese workers have seen two years of falling real wages and this may very well be suppressing Japanese consumer activity. An argument has been made that consumption growth would only return after consumers have recouped the purchasing power they’ve lost as a result of yen weakness related inflation. Moreover, that consumers would need several quarters of wage growth outstripping prices before a restoration of confidence would restore consumer spending to the point of sparking domestic inflationary pressures.
The phase of japans economic cycle and the intentions of economic policy are diametrically opposed to that of most other advanced economies, and so Japan actually pursues the exact opposite of what most other economies are trying to do. Well, to a point; they’re all trying to do the same thing in terms of end goals, restore price stability and healthy economic activity, but the Japanese policy makers are coming at it from an entirely different place.
In most other countries, labour markets have been tight and service inflation has been sticky to the point that markets are wondering when rate cuts could even begin. Rates cuts that had been previously priced in by participants are no longer expected. In contrast, Japans problem is that their service inflation is too low and must be risen if hopes for economic growth are to be achieved. Another important factor is that Japan’s corporate sector has had sufficient profits that enables big companies to recognise the demographic problems being faced by the country to the point that they can spend on capex to replace workers with capital.
A quick glance at Nikkei would perhaps make you believe that japan’s economy is performing okay as Japanese companies are posting record profits for the third year in a row, with profits 13% higher than the year prior and 6% higher than the year before that. Manufacturing profits are on target to grow 16% this year, with non-manufacturing hoping to climb 11%; both of which would see profitably at record highs. Japanese capex intentions are measured by the Tankan survey, which is also at multi-decade highs; previous peaks being around 6% to 7%, but the latest cycle has been up at 15%. Whilst previous predictions have been off by some 1-2%, the capex has seen 7-8% in growth already.
But Japans economy is anything but fine. Part of the driving factor behind the current corporate profitability in Japan is directly related to yen weakness and not Japans economic health. This is because most Japanese companies look to international markets for sales, growth, and investments. So whilst the yen has been spiralling, most of the companies listed on the Nikkei have international reach that has seen profits soar; partially due to yen weakness and partly due to loose monetary policies at home.
As we all know, one can’t simply devalue a currency to generate or inflate wealth but the yen’s decline has improved business profitability. Which I assume Japanese policymakers hope will lead to wage growth and capex. Currently, it has brought about inflation in a country that has suffered 3 decades of deflation, so I can understand why policymakers hope it will instigate consumer spending, before prices rise further… stimulating broader economic activity. But this approach has limitations and there’s obviously a limit to where everything can go. The BoJ discussed in a report that they are fairly confident that over a period of time, the Japanese economy will transition into a positive output gap, and that positive output gap will result in a steady income growth for workers which will lead to a sustainable growth in consumer spending. This being the ‘virtuous cycle’ the BoJ are predicting will ignite the furnace of the Japanese economy. A positive output gap only happens when demand is very high; actual output is greater than full-capacity output. In a situation where machines, workers and businesses are being stretched past capacity, companies end up having to pay more for everything in order to run at such levels which results in higher wages as overtime demand must be met. However, over time, companies must increase worker productivity, usually by spending capital on increased mechanisation, which is a necessity in Japan due to their aging population. This positive output gap isn’t sustainable in the long run but can be sustained over short periods of high economic demand, the main problem in Japan is that the origin of the demand responsible for this output gap is from overseas and due to domestic drivers. The idea that this positive output gap will feed into a domestically induced inflation rate is one that I’m uncertain about. It can create a situation in which production becomes amazingly high-tech, but how will that translate through to the labour market; workers replaced by mechanisation? I don’t know, I suspect a state subsidy will likely be introduced derived from the increased profits generated by mechanisation, but that quite some time off and Japan is a country that still has plenty of room for a healthy increase in such activities. Japan’s debt reached 8.6 trillion USD at the end of 2023, and at 255% of GDP, its more than twice the debt to GDP ratio of the US and is the highest in the developed world. Japan also has an aged population which is projected to produce the same number of retirees as workers by 2050.
Profits as mentioned earlier are at an all-time high, but real wage growth has remained weak and that is the main reason why policy makers are reluctant to increase rates and are pushing hard for higher wages. The BoJ have stressed that the timing of their decisions will be dependent on factors associated with wage growth in which policymakers are are hoping to see an increase in wages which will result in higher spending which will trickle through to the wider economy. This is a big change in a country that has seen stagnant wages and deflation for over three decades, people who have been salaried have actually benefited from this as wages, whilst flat, have been purchasing more goods due to the cycle of deflationary pressures. This creates an environment which is prone to low innovation and reduced risk appetite which is also a significant issue in Japan’s economy. But current labour shortages are forcing reforms which are resulting in the younger generation adopting a greater entrepreneurial spirit which is slowly improving economic diversity and slowly providing the BoJ with the confidence to raise rates as real wage growth becomes entrenched. In March, a 5.28% wage rise was agreed which is the biggest pay rise in 33 years. This change is a factor which impacted the decision to end the negative rate policies. Ultimately policy makers are worried about the yen for two reasons, the first being an erosion of corporate expectations, which makes little sense. And the second is that such a severe decline in yen strength could cause the wrong type of inflation as discussed earlier. Whilst this is economically sound, the corporate profits have been a function of a weak yen and if they try to strengthen the yen will hurt company profits and reduce the output gap and any future wage gains. This is the first time in the last few decades that corporate inflation expectations in Japan have actually increased substantially, but that’s because the government is on their case to lift wages, in-part due to the reduction in government party approval ratings which has been significantly damaged of late due to the fall of real wages. So now there’s building political motivations which are starting to impact the yen. Perhaps this may be the most significant factor in stimulating inflation as that would bring about the right kind of inflation, so policy makers need the domestic labour market to remain tight. The BoJ are also reluctant to raise rates because goods inflation is reducing whilst services inflation is significantly lacking.
The big winners from the weakness in yen are obviously the large cap companies who’ve generated global profits but remain denominated in yen; exporters who receive foreign exchange and financial firms with exposure to financial markets. Also the tourism sector has been running hot with the monthly visitors exceeding 3 million for the first time in March and climbing, again driven by a weak yen. When you combine a low yen with 30 years of stagnant wage growth it doesn’t exactly spur on economic activity.
In recent times, Janet Yellen has said that the G7 have agreements in place stating that any interventions should be implemented to smooth volatility only and not to influence exchange rates, which may explain why previous interventions haven’t had much success and have always been at times of rapid price movements. Her comments also suggest that Japan has not discussed any interventions with other G7 nations prior to stepping in, which they are duty bound to do so. Generally, any exchange interventions are a bilateral arrangement and successful interventions would likely involve a discussion between both sides; the fed in this case. This could again indicate why previous interventions have not worked and why they seem to be triggered in time with negative US news during hours of extremely low volume. Perhaps the BoJ should learn from the lessons taught by both turkey and Egypt who both failed in this endeavour, essentially squandering their entire respective central bank reserves on attempting to maintain an artificial fx price, one which later collapsed as soon as reserves dwindled. This leaves traders wondering, is there any point at intervention if the underlying problems are too great to justify a stronger yen in comparison to its western counterparts.
For me, it’s the pace at which the yen is declining which is most interesting, and this is starting to spook Japanese consumers which could very well result in a reduction of spending, which is the polar opposite to what the BoJ requires, so in that sense, intervention perhaps serves its purpose in which the ends inevitably justify the means. But at this rate some Japanese pundits are wondering if Japan will slip back to becoming an emerging market once again, which I don’t think is a serious possibility, just more of a motivational tactic. Whilst Japan’s economy has many problems, the risk of becoming an emerging market doesn’t seem so great, nor does it seem likely.
Ultimately, the main reason behind this post is to highlight the many factors behind the current exchange rate and to shine a light on nuanced economic policy that drives the yen lower. Personally, I think for any intervention to have any meaningful impact on currency prices, the government needs to reinforce the need for higher wages in order to stoke the flames of domestic inflationary pressures whilst the BoJ and the MoF work together, raising rates substantially backed by monetary intervention. But that should be at a time when the US either eases rates or the economy starts to show signs of slowing (which it has in its recent data prints). Lower inflation in the US seems to be the most likely scenario that would reduce the pressure that currently weighs on the yen as that would reduce rate differentials without Japanese intervention. In my opinion, that would seem like the perfect opportunity for Japanese policy makers to act in tandem; with intervention at the same time as rate rises. Furthermore, as Japan slows its rate of treasury purchases, the repatriation of yen will stem capital flight but it’s yet to be seen if that will be enough to stem further weakness.
What do you think… is the current price justified or is it due for an imminent mean reversion?
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